Probability Based or Safety First: Which Retirement Income Approach Aligns with You?

Scott Sullivan |
Categories
Retirement Planning

When planning for retirement, it's crucial to recognize that there isn't a one-size-fits-all approach. Your unique preferences, financial goals, and comfort level with different types of risk are paramount in determining the most suitable strategies for your retirement income. This is where understanding two fundamental philosophies of retirement planning – Probability-Based and Safety-First – becomes essential.

These two approaches represent distinct ways individuals decide where to place their trust in retirement: in the risk/reward possibilities of an equity portfolio or in the contractual guarantees of insurance products.

The Probability-Based Approach

The Probability-Based approach generally appeals to those who are comfortable with market volatility and believe in the long-term growth potential of investments. This philosophy accepts market risk, relying on historical returns and statistical probabilities to project the likelihood of sustaining withdrawals from investment portfolios. Key characteristics include:

  • Primary Goal: To maximize growth potential for aspirational goals and achieve risk-adjusted returns from the total portfolio.

  • Risk Management: Individuals retain market risk, counting on statistical success rates. The strategy seeks to earn the risk premium from the stock market and other risky assets.

  • Income Sources: Typically involves drawing income from a diversified investment portfolio of stocks and bonds.

  • Flexibility: Investors value maintaining optionality and avoiding commitments that limit future changes. They prefer flexibility to adapt to market conditions and life changes.

  • Common Strategy: The Total Return strategy, often associated with variations of the 4 percent rule for withdrawals, falls into this category.

However, relying solely on investments means your plan is vulnerable to depletion if markets perform poorly, especially early in retirement (known as sequence of returns risk). This can be emotionally overwhelming or dangerous, as investments alone do not necessarily create an efficient retirement plan.

The Safety-First Approach

In contrast, the Safety-First approach prioritizes eliminating risks to essential expenses by utilizing contractual guarantees. This philosophy aligns with those who seek stability and predictability for their core living expenses. Core aspects of this approach include:

  • Primary Goal: To guarantee essential expenses for life. This is achieved by building a floor of guaranteed income.

  • Risk Management: This approach focuses on transferring risks like longevity and market volatility to insurance companies or other entities through risk pooling mechanisms. It aims to avoid exposing core spending to market swings.

  • Income Sources: Relies heavily on protected income sources such as Social Security, pensions, and annuities. Annuities, for example, can provide a guaranteed income stream for life.

  • Flexibility: While some contractual commitments may reduce flexibility over certain assets, the peace of mind derived from guaranteed income can provide greater overall spending permission and reduce anxiety.

  • Strategic Tools: It often involves using tools like reverse mortgages for strategic liquidity or whole life insurance cash value as a volatility buffer to avoid selling depreciated assets during market downturns.

The Safety-First approach recognizes that constantly needing to adjust spending from a volatile portfolio is unrealistic. It advocates for matching strategies to specific needs, such as using guaranteed income for essentials and market-based investments for discretionary spending.

Discovering Your Retirement Income Style Awareness (RISA®) Profile

Given these two distinct philosophies, how do you determine which aligns best with you? This is where the Retirement Income Style Awareness (RISA®) Matrix comes in. The RISA® Matrix provides a systematized way for individuals and their advisors to quickly understand their preferences and align them with suitable retirement income strategies.

The RISA® Matrix assesses your preferences across two primary factors:

  • Probability-Based vs. Safety-First: Are you more comfortable with market growth or with contractual protections as an income source for your essential retirement spending?

  • Optionality vs. Commitment: Do you emphasize keeping options open, or do you prefer to commit to a strategy designed to solve for a lifetime retirement goal?

By understanding your RISA® Profile, you can gain valuable insights into which of the four distinct retirement income styles—Total Return, Income Protection, Risk Wrap, or Time Segmentation—you might find most comfortable and sustainable. Interestingly, research indicates that approximately 67% of individuals are looking for strategies that extend beyond a purely Total Return investing approach, often seeking greater contractual protections and commitments for their essential expenses.

To build a comprehensive, personalized retirement income plan that effectively manages key retirement risks like longevity risk and sequence of returns risk, it's highly beneficial to work with a qualified financial advisor. They can help you assess your unique goals, determine your RISA® profile, and integrate multiple income sources—including Social Security, pensions, investments, annuities, and strategic use of home equity—into a strategy tailored specifically for you. This integrated approach aims for increased confidence and reduced anxiety, along with potentially higher and more sustainable income and a greater legacy.

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